Insuring the Cannabis Industry – Grass is Greener with Captives
Businesses operating in the cannabis industry face risks – just like any other business. Though some of those risks are unique to the industry, they are real, and they must be managed. Marijuana businesses are sprouting in record number as states like Colorado legalize private growing, distribution, and sale. Many states appear to be moving toward decriminalization or even full-blown legalization. California voters have the opportunity to vote for or against legalization in November this year. The cannabis industry is growing like weeds, like it or not. Successful entrepreneurs in the marijuana business must contend with considerable legal and regulatory risks that drastically inhibit the viability of the industry itself. In other words, most businesses do not engage in trades that are illegal under federal law. Some might see possible federal prosecution as a deterrent, but not this industry. But these challenges preclude many marijuana businesses from acquiring liability insurance, which is fundamental for its legitimate existence.
Although cultivation and distribution may be legal under some state laws, it is still a crime under federal law because marijuana is classified as a Schedule 1 drug under the Controlled Substances Act. For several decades, the Controlled Substances Act has made it illegal to “manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense” marijuana.
The states are powerless to change this: the Supreme Court has confirmed that the federal government has the right to regulate and criminalize the sale and use of cannabis, even when state law permits the use for medical purposes.
But it does not stop there. Federal law also punishes those who aid and abet or conspire with criminals. Anyone who “aids, abets, counsels, commands, induces, or procures” the commission of a federal crime by another is punishable as a principal, as though he or she had committed the offense. Providing insurance to a cannabis business could arguably subject the insurance company to a criminal charge of aiding, abetting, or conspiring to violate the Controlled Substances Act.
Despite this uncertain climate, an active market exists through which cannabis businesses can acquire traditional commercial insurance. However the premiums for this insurance are typically more expensive than that of other businesses due in part to the limited number of companies competing in the cannabis industry. The lack of historical risk of loss data and the questionable legality also contribute to increased insurance costs.
However, captive insurance may be an appealing option for some cannabis businesses.
Historically captive insurance has presented an effective solution for businesses facing more exotic business risks for which coverage was not available or affordable, such as products liability or toxic tort exposure. In addition, captives should essentially be unaffected by the risk of federal prosecution for violating drug or money laundering laws. Concerns about prosecution clearly prevent some commercial insurance companies from entering the market. For example, in June 2015 Lloyds of London instructed its syndicates to cease underwriting and providing insurance to marijuana businesses. But cannabis businesses have already committed to and assumed the risk of prosecution. Forming a wholly owned private insurance subsidiary would seem to subject the cannabis parent business to no greater risk of prosecution than it faced without the coverage.
The captive arrangement is also less likely to be abused as a tax shelter. The Internal Revenue Service prohibits marijuana companies from deducting their business expenses, even if allowed under state law. Section 280(e) of the IRC holds that no deduction or credit shall be allowed for any amount paid in carrying on any trade or business if federal law prohibits such trade or business. Thus at this time, a marijuana company has no motivation to artificially generate business deductions through premium payments because it is generally disallowed those deductions in the first place.
— By Michael S. Cooper, Esq., Barnes Law
Michael Cooper is an associate attorney with Barnes Law, and is licensed to practice law in California.
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 See Gonzales v. Raich, 545 U.S. 1 (2005)
 18 U.S.C. §§ 2, 846
 18 U.S.C. § 2